The failure to address the looming too-big-to-fail issue

Last week I was at the Clinton Global Initiative Annual Meeting to listen to their ideas on how to solve some of the world’s most pressing problems like poverty and education. I may have more to say about this topic in a later post, but I wanted to first address the too-big-to-fail issue which became a central focus of a panel discussion that featured regulator Sheila Bair and bank CEOs Peter Sands and Jamie Dimon.

The ostensible topic of discussion was “Moving from Crisis to Opportunity – Financing an Equitable Future” and it centered around how to use the developed economy’s financial system to better the lives of the poorest. The moderator was Maria Bartiromo and the most topical panelist was Fale Abed, Founder and Chairman of BRAC, a group that works with people whose lives are dominated by extreme poverty, illiteracy, and disease by providing microfinance, education and health care. However, given the day jobs of the other panelists, the discussion quickly turned to the financial crisis and its aftermath.

What I found interesting was the general agreement between Dimon, Sands and Bair that regulatory reform to date has been a bust. Bair was typically diplomatic in underscoring the things she would like to see done in the future. Nevertheless, I was certainly left with the impression that she is not holding her breath that anything substantive is actually achieved. In fact, the conversation made clear that Bair, Dimon and Sands all felt that the first and most important bit of financial reform must be to set up a resolution process in order to deal with too-big-to-fail institutions. Let me characterize Dimon and Bair’s remarks below.

Jamie Dimon. It is clear that Dimon believes JPMorgan Chase was never in any real jeopardy during the financial crisis. He spoke on several occasions about the lack of a resolution crisis to deal with large firms without mentioning any names, but clearly intimating that other beleaguered institutions like Citi and BofA were saved by this. He said that the financial crisis should not be used as an excuse to break up large institutions (like his) because the crisis was the result of bad lending as in any other crisis. He said, smaller imprudent lenders are being liquidated systematically by the FDIC. The only reason larger companies did not face liquidation is because no resolution mechanism was or still is in place to deal with them. Whether he sees Washington Mutual in this same light, I do not know. He was not asked whether JPMorgan Chase benefitted from its demise. Interestingly, every time he mentioned his firm by name, he said JPMorgan not JPMorgan Chase or Chase, the legacy bank he came from.

While Dimon gave Paulson, Bernanke and Geithner a free pass for letting Lehman fail, resolving the too-big-to-fail issue is priority number one for any new regulation for Dimon. He said the present reform proposals are not heading in the right direction and used an analogy saying, “If we had a problem with our legal department, I would tell the guys to fix the legal department. If the government had the same problem, it would create a second new legal department.” Over-regulation is not the answer. Smart regulation is.

Sheila Bair. Bair was in stunning agreement with Dimon on the core issues. She too said the first priority of any financial regulation must be to put a resolution mechanism in place to deal with too-big-to-fail institutions. She rejected the concept of the Federal Reserve as the main financial regulator, something even Ben Bernanke is now rejecting. But, she disagreed with Dimon. Instead she felt that the financial system had veered excessively into derivatives and other complicated financial products and that this was a major contributor to the financial collapse. She advocated regulating these and increasing the focus on traditional banking products typical in community banking. It was clear from these remarks that she favors community banks over too-big-to-fail institutions.

Bair also tipped her hand on the New York Times flap about allowing the FDIC to borrow from the banks it regulates. She indicated there was no real possibility this would occur even though it is legally permissible and one option they were considering.

On the issue of the developed economy financial system’s help with issues central to the poorest, Abed was at home. But, Sands had deep knowledge of the issues as well. I was impressed. On the issue of the financial system and regulatory reform, I left this session feeling that everyone but the Obama Administration and Congress knows what needs to be done. When two big bank CEOs and the chief bank regulator are singing the same tune but no one in Washington or London is listening, you have a clear case of capture. When crisis comes again, this issue will loom even larger.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

What’s a nice guy like you doing among filth like these, Ed? Th only way vermin like Bair could manage to articulate an truly infornative and straight-forward answer to a question woulld be if you slipped them a $100 bill in advance of asking it. I mean really:

“She indicated there was no real possibility this would occur even though it is legally permissible and one option they were considering

It means she was embarrased that the fact they were even considering this option leaked. But because it did, she had to give lip service to its plausibility even while denying it was under ‘serious’ (her word) consideration.